To what degree has the high concentration of Community Reinvestment Act (CRA)-motivated bank investment in low-income housing tax credit (LIHTC) properties affected the price of LIHTCs? The answer to that question was an unknown—until now.
Over time as investors and regulators have become increasingly confident in the performance of LIHTC properties, housing credit investments have become a highly favored CRA-qualified investment vehicle for banks. An unintended result is that the LIHTC program has become highly reliant on equity investments from banks.
A new study published by accounting firm CohnReznick assessed the degree to which the high concentration of CRA-motivated bank investment has affected the price of housing tax credits.
In theory, a dollar of housing tax credit should be worth a dollar to investors, whether it is generated by a property in Martinsville, W.Va., or one in San Francisco. However, the CohnReznick report has illuminated how the price of housing tax credits is driven predominantly by the CRA investment test value of a given property’s location, second only to yield.
The collected data shows large spreads in credit pricing (as much as $0.35) at the extreme ends of the spectrum, between what CohnReznick calls “CRA Hot” areas—typically major urban markets—and “CRA Not” locations, which can be smaller, more rural communities, or more populated areas that do not fall within the CRA “footprint” of one of the major commercial banks. These gaps cannot be explained sufficiently by factors other than CRA.
The causes of the pricing spread become clearer when you examine the factors that determine CRA investment test objectives and the way in which tax credits are distributed. State housing agencies allocate LIHTCs to projects according to annual qualified allocation plans. Demand by banks for LIHTC investments, on the other hand, is largely tied to CRA regulations, which focus on areas where branch locations and deposits—and consequently, investment test requirements—are the highest.
The effect of increased consolidation among the top U.S. banks has resulted in more competition among each other in the same markets. As a result, banks’ CRA assessment areas overlap more and more in major metro areas, and deposits are concentrated in a fashion that is not consistent with population levels.
The resultant investment test obligation of banks in these markets funnels capital to areas that have a disproportionately small number of new LIHTC investment opportunities. As a result of this imbalance of supply and demand, LIHTC projects in CRA Hot locations command significantly higher prices. This imbalance increases pricing in these markets to as high as $1.25 per $1 of housing tax credit.
Between 2005 and 2007, when LIHTC equity volume peaked, housing credits were valued more or less at par ($1 per $1 of tax credit) in many locations. When Fannie Mae and Freddie Mac were still in the market, the statewide spread in median tax credit pricing between states with the highest level of CRA demand and states with the lowest level of CRA demand was $0.14.
But during 2008 and 2009 when Fannie and Freddie exited the LIHTC market and equity demand plummeted, the price for housing credits in CRA Hot locations proved highly resistant to sharply lower demand while projects in certain CRA Not locations had difficulty attracting equity at any reasonable price. The spread between tax credit prices in CRA Hot versus CRA Not locations more than doubled.
The effect of CRA on tax credit pricing in Louisiana is revealing. From 2000 to 2006, median tax credit pricing was an average of $0.04 less than the national median. However, in 2006 the Federal Reserve Board said it would grant favorable consideration to banks that invested in areas affected by hurricanes Katrina and Rita, even if they were not doing business in these areas.
It is not surprising that the median price of housing tax credits in Louisiana after 2006 was equal to or greater than the national median. The influx of CRA-motivated capital was directly triggered by the decision to relax the regulations that define assessment areas.
All else remaining constant, the more the LIHTC equity market is dominated by CRA-motivated investors who invest only in certain areas of the country, the wider the pricing spread one may expect to see between areas with intense CRA compliance demand and areas without.
The “partnership” between CRA investment objectives and the LIHTC program has been a great success. Nonetheless, CohnReznick thinks that partnership would be stronger if banking regulators adopted a more flexible methodology for granting positive CRA consideration to LIHTC investments.
CohnReznick also suggests that banking institutions be given CRA credit for investing in projects that meet critical housing needs in wider statewide or regional areas that include the banks’ assessment areas. This would help narrow the pricing spread observed in some areas.